The financial ratio days’ sales in inventory (DSI) tells you the number of days it took a company to turn its inventory, also known as inventory turnover. This ratio would also include goods that are in progress of being sold. Keep in mind that a company’s inventory will change throughout the year, and its sales will fluctuate as well. Therefore, you should view this as an average from the past.
DSI is also referred to by average age of inventory, days inventory outstanding (DIO), days in inventory (DII), days sales in inventory or days inventory and is interpreted in multiple ways. Yeah, takes some time to get use to saying that.
Indicating the liquidity of the inventory, the figure represents how many days a company’s current stock of inventory will last. Generally, a lower DSI is preferred as it indicates a shorter duration to clear off the inventory, though the average DSI varies from one industry to another.
Calculating DSI
DSI = (Average Inventory / COGS) X 365
- DSI – Days Sales Of Inventory
- COGS – Cost Of Goods Sold
Now, in order to manufacture a product to sell, the company is going to need raw material and other resources from inventory. As always, there’s always a cost associated to the materials. You’ll also have cost associated to the manufacturing of the product using inventory.
When you include the cost of labor and utilities like electricity or water, this is represented by the cost of goods sold (COGS) and is defined as the cost of acquiring or manufacturing the products that a company sells during a period. DSI is calculated based on the average value of the inventory and cost of goods sold during a given period or as of a particular date.
Mathematically speaking, the number of days in a period are calculated using 365 for a year and 90 for a quarter. It’s important to note that some companies will use 360 days versus 365 days.
The numerator figure represents the valuation of the inventory. The denominator (Cost of Sales / Number of Days) represents the average per day cost being spent by the company for manufacturing a product to sell. The net factor gives the average number of days taken by the company to clear any inventory they have on-hand.
There’s 2 different versions of the DSI formula that can be used depending on how the accounting is done.
In version 1, the average inventory amount is taken as the figure reported at the end of the accounting period, such as at the end of the fiscal year ending June 30. This version represents DSI value “as of” the mentioned date.
Version 1: Average Inventory = Ending Inventory
Version 2: Average Inventory = (Beginning Inventory + Ending Inventory) divided X2
In version 2, the average value of Start Date Inventory and Ending Inventory is taken, and the resulting figure represents DSI value “during” that particular period.
Now, the COGS value for version 1 and 2 will stay the same..
What Can DSI Tell You?
There’s a lot of takeaways that DSI can give you. Since DSI indicates the amount of time a company’s cash is tied up in its inventory, the aim is low DSI values for the company. If a company scores a low DSI, that company frequently selling its inventory, which usually results in higher profits, if sales are being made in profit that is.
On the other side, a large DSI value is going to suggest that a company may be struggling with high-volume inventory, which is never a good thing. It is also possible that the company may be retaining high inventory levels in order to achieve high order fulfillment rates, such as in anticipation of bumper sales during an upcoming holiday season. A great example of this would be Black Friday or Christmas.
DSI can be measure of the effectiveness of inventory management by a company.
Think about it, inventory is usually a big investment of the operational capital requirements for a business. By calculating the number of days that a company holds inventory before it’s sold, this efficiency ratio measures the average length of time that a company’s cash is tied up in inventory.
While DSI is a good indicator in certain scenarios, you have to view it cautiously. DSI values calculated for brick and mortar retail (Target), online retail (Amazon) and technology (Adobe) sector companies, DSI can vary greatly among industries depending on many factors;
- Industry Type
- Product Type
- Business Model
Due to this, you should be comparing value among their same sector peer companies. Here’s a really good example why. When you look at technology, automobile, and furniture sectors, these companies can hold inventory for long durations. However, if another company is selling eggs, those products have a limit. As you know, eggs go bad, so these companies need to move inventory as quickly as possible.
One must also note that a high DSI value may be preferred at times depending on the market. This is where it gets tricky and you really have to pay attention to the “context” of the scenario versus just the DSI result.
Company A may have inventory it wants to hold onto because they know next quarter, the value for that inventory is going to be worth twice as much. Although they’ll have a higher DSI now, that move is going to lead to higher profits in the next quarter when it’s sold.
Why Is Days Sales Of Inventory Important?
Properly managing your inventory levels is vital for all businesses, even more so for those of you that have retail companies or those selling physical goods. While inventory turnover ratio is one of the best indicators of a company’s efficiency for turning over its inventory and generating sales, the days sales of inventory ratio goes a step further by putting that figure into a daily context and providing a more accurate picture of the company’s inventory management and overall efficiency.
DSI and inventory turnover ratio can help investors to know whether a company can effectively manage its inventory when compared to competitors. For investors, that’s another key metric that gives them insights into the value of a company.
*Accelerated Analytics publishes resources like this to provide insights to different analytical metrics, data points and formulas. Please be aware, we’re not claiming that our POS reporting services will offer this example or any other metric, data point or formula. To learn exactly what our reporting covers, please feel free to schedule a demo or give us a call. Thanks for understanding.
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